I maintain that it wasn’t a bait-and-switch, but rather a delectable and necessary build-up to today’s post. In particular, it was important to showcase the need for the administrative file (that is, facts IRS Counsel should have access to) and the distaste the Tax Court has shown for “bureaucratic inertia” as an excuse for Counsel failing to ascertain facts known by the IRS more broadly. Today, I promise to (actually) discuss remedies to the ubiquitous “deny for lack of sufficient information” answers plaguing the low-income taxpayer docket.
When I file a petition, Tax Court Rule 33 ensures that I can’t just allege facts without reasonably inquiring into their veracity. It stands to reason that if I am bound by Rule 33 in alleging facts, the IRS is bound by Rule 33 in denying knowledge of those same facts. Of course, as the taxpayer/petitioner, I generally have both the burden of proof and better access to the “facts alleged” than the IRS. And because the IRS (usually) need only respond to my factual allegations, they usually deny and move on.
The question is how much of a “reasonable inquiry” IRS Counsel needs to do before they can throw up their hands and say, “we deny that fact for lack of sufficient knowledge or information.” For example, can IRS Counsel in Minnesota “deny for lack of sufficient knowledge” what IRS Appeals in Utah knows fully well about the case?
It is an issue of how much knowledge should be imputed from one area of the IRS to another. But it is also an issue of how much effort IRS Counsel must expend in actually trying to learn what IRS Appeals or Exam already knows. The first issue is with regards to knowledge. The second issue is with regards to effort.
Knowledge and Effort: You’ve Got to Try to Learn the Facts
Let’s begin with the lesson from my last post. IRS Counsel cannot just blame the “bureaucratic inertia” of other IRS functions (e.g., Appeals) for its failures to act in a timely manner. Recall the case of Vermouth v. C.I.R., 88 T.C. 1488 (1987). While Vermouth dealt with the IRS’s failure to timely file an answer (rather than timely filing a “bad” answer) under Tax Court Rule 36, it should remain relevant under Rule 33 concerns.
Exactly how hard IRS Counsel needs to try for the effort to be a “reasonable inquiry” may be subject to debate. At a minimum, I’d say that if the IRS (somewhere) has access to the facts alleged, IRS Counsel can’t (or shouldn’t) be able to just lamely deny for “lack of sufficient knowledge” because that other function hasn’t been on the ball in sending the information to IRS Counsel.
But you don’t have to take my word for it…
The Importance of the Answer: Litigation Costs
In perusing the US Tax Court’s orders, I came across the interesting case of Dudley Joseph & Myrna Dupuy Callahan v. C.I.R., Dkt. # 6999-09. One particular order caught my eye, which granted the pro se petitioners litigation costs for their troubles… generally a sign that the IRS didn’t do a great job in the case.
My suspicions proved correct.
In this case, the petitioners received a CP2000 Notice for their 2006 taxes for (allegedly) failing to report gambling winnings, social security, and $27 in interest. The problem was that the petitioners did, in fact, report all those things (except the interest, which they denied receiving altogether). They just didn’t report all those things in exactly the place the IRS AUR computer wanted them to.
Most of the confusion boiled down to the treatment of the gambling winnings. Petitioners did, in fact, report their winnings, but as Schedule C (i.e., self-employment/business) income. Generally, one could dispute that tax treatment, but in petitioner’s case they had already been audited on exactly that issue in the past, and apparently the IRS had agreed it was Schedule C income.
After being unable to resolve the issue by responding to the CP2000 (surprise!) petitioners received a Notice of Deficiency (NOD). They took the belt-and-suspenders approach by both petitioning the tax court and replying (again) to the IRS office in Philadelphia that had issued the CP2000.
Somewhat surprisingly, this time the CP2000 response worked. The IRS issued a “CP2005” closing letter agreeing with the return as filed. The closing letter went so far as to say, “If you have already filed a petition, the Office of the District Counsel will contact you on the final closing of this case.”
And yet, here we are in Tax Court. What went wrong?
Basically, IRS Counsel didn’t really look into things. Rather than conceding the case, they filed an answer that continued to assert the full deficiency as well as an accuracy penalty for good measure. When they were (eventually) presented with the CP2005 closing letter the IRS conceded… but by then significant time and effort had been wasted. Enough so that the Tax Court found that the petitioners should be awarded the costs of their tax court filing fee and mileage for driving to court.
For present purposes I want to focus on whether the IRS’s position (as framed in its answer) was substantially justified. If it was, then under IRC § 7430(c)(4)(B) no award of fees would be forthcoming. Here is where Judge Gale hits on that Rule 33 requirement I began with:
“Respondent has not asserted, and there is no evidence to support, the proposition that respondent undertook any investigation before filing his answer of petitioners’ claim that the disputed gambling and social security income had in fact been reported. We believe that only a modest amount of investigation of the averments in the petition would have confirmed petitioners’ claims and/or revealed the existence of the Closing Notice, issued more than 3 months before the answer.” (Emphasis added.)
Judge Gale then drops a footnote to Rule 33(b). It is in no small part because of the failure to really investigate the facts that the position of the IRS was not, in this case, substantially justified.
Of course, this was all in an order and is not part of a precedential opinion. Nonetheless, it is worth noting that Judge Gale’s position could open up a lot of opportunity for litigation costs if the IRS doesn’t start doing a better job with its answers. Usually, practitioners need to rely on the “qualified offer rule” (IRC § 7430(g)) to get fees because the “substantially justified” exception is such a low bar for the IRS to meet. But maybe not, if the IRS doesn’t meet its Rule 33(b) requirements when filing an answer.
As far as remedies go, my bet is that the awarding of litigation costs would be enough to get IRS Counsel’s attention next time they have to file an answer. But the fun doesn’t stop with the greater potential for litigation costs. In my next post, I’ll cover still more possible remedies for answers that do not appear to meet the requirements of Rule 33(b).